Head of FX Strategy
Summary: The US dollar continues to consolidate to the strong side as the Biden presidency approaches, one that was meant to weaken the US dollar further, given the slim Democratic control of Congress, but with the market constantly trying to operate on far future expectations, it may simply have gotten ahead of itself. Soon, however, this consolidation will become a bit more threatening for the USD bearish case if it continues.
USD: consolidation reaching pivotal levels
The US dollar has managed to pull higher still since the weak close on Wall Street on Friday, with sentiment still a bit edgy ahead of this Wednesday’s Biden inauguration and despite a near total lack of unrest across the US at the weekend after warnings were loudly trumpeted from official quarters. Supposedly, we should also be concerned for protests on Inauguration Day itself, but the hopeful view for public order is that the Capitol Hill riots were a one-off, down to the presence of a gaggle of the most extreme Trump supporters and a mob mentality excited by a number of fiery speeches from Trump and others that goaded them on.
Assuming an orderly transition, there are still a number of burning questions looming as Biden takes office, from whether and how quickly his administration can do anything about the vaccination effort and winning the race against hyper-contagious Covid strains, to the temperature in Congress (most importantly among a key handful of senators) on stimulus checks and other stimulus measures, as well as more specific, one-off issues like the Keystone pipeline, which could heavily impact USDCAD if cancelled (more below). I will also be keeping a close in eye in the first weeks of the new administration on signals from the Biden administration on China and on Russia, where sanctions are a looming threat after accusation that Russia is behind a recent cyber-attack of US government agencies and as the Democrats still claim Russian interference in the 2016 election. There is also the issue of the detention of opposition leader Navalny, who returned to Russia at the weekend. The outgoing Trump administration has also moved rather aggressively against China on a number of fronts and the market may be taken aback if the Biden administration doesn’t soften its stance (due to a domestic audience) against positions that the Republicans have now staked out on Chinese companies and listings on US exchanges, among other issues.
While we await all of this incoming information, the USD consolidation has reached reasonable, consolidation levels without yet breaking anything. And while full trend reversal levels remain some ways off, further USD strength in the near term begins to stress the USD bearish case. One thing that is most concerning for the risk of a more profound USD rally here is one of positioning. As I noted in this morning’s Saxo Market Call podcast, the fact that EURUSD speculative long positioning never reached a new high despite the new highs in EURUSD is some cause for concern – i.e., less participation at higher levels. This kind of divergence has marked a major market turn in the past. Still – too early to tell. I suspect that any more large-scale USD rally would most likely be on a partial position unwind due to a more significant setback in risk sentiment than we have seen in a long while after the remarkable post-pandemic breakout blitz of bullishness in response to the liquidity tsunami.
Today is a US national holiday (Martin Luther King, Jr. Day), so the action is likely to slow later today as US markets will be off-line.
US Treasury Secretary nominee Janet Yellen set to testify tomorrow. The former Fed Chair is set to testify in a nomination hearing tomorrow and people close to her say she will express a belief in a market-determined dollar level (and explicitly not in favour of a weaker US dollar for competitive advantage). Supporting a strong, or at least stable, dollar has been the role of the US Treasury Secretary for decades now, since Clinton's Treasury Secretary Robert Rubin at least, even under Trump’s Secretary of Treasury Mnuchin when Trump was often railing against the Fed and USD strength.For Yellen specifically, USD support is doubly ironic as she was a very dovish Fed chair and was at the helm of the Fed during the famous pivot in Fed guidance in early 2016 to delay hiking rates after a period of brutal US dollar strength.
Chart: EURUSD
EURUSD has tumbled down to its first major support level, the 38.2% retracement of the entire rally wave from the November lows – a reasonable level for the bulls to re-establish positions. Looking lower, if this consolidation continues, the psychological and de facto support area around 1.2000 is the next key pivot zone, with the 1.1900 area and nominal 61.8% Fibo level below that the near-term existential level for the USD bears in this pair, because if the pair trades below there, a more profound breakdown and setback for the USD bears could threaten.
The G-10 and CNH rundown
USD - Broadly weak risk sentiment supporting the USD now, whereas it was formerly the yield spike – an interesting tightrope walk to get the right combination (for USD bears, at least) of strong risk appetite without US yields rising too quickly.
CNH – the renminbi is joining the USD consolidation parade as USDCNH pulls back north of 6.50, which was a major milestone on the way down, a further sign that the USD bearish case is under near term stress.
EUR – as noted above, the key psychological support area is 1.2000, with the 1.1900 zone carry more technical significance. Italian politics could be weighing here, though the market expression of this is not by any means dire yet in BTP’s.
JPY – the yen quite firm in the crosse sand even keeping pace with the US dollar over the last session as long US yields have backed down. EURJPY is tumbling aggressively.
GBP – the sterling rally has stalled out a bit after EURGBP looked interesting last week and now GBPUSD is facing a test of the key 1.3500 area. Still like EURGBP lower if the pair stays south of 0.8950.
CHF – getting a mild bid on safe haven flows and yields backing down again.
AUD – a decent consolidation in AUDUDS that doesn’t look more threatening until/unless the 0.7600-25 area gives way, though really the trend can stand a test of 0.7500 and even the 0.7400-25 pivot zone without signs of reversing. All depends on how quickly the reflation trade resumes.
CAD – Biden may cancel Keystone pipeline – critical for opening up more access for Canada’s crude deliveries – but the pipeline is fighting back with plans for making the pipeline “carbon neutral”. This announcement on go/no-go for Keystone could be critical for USDCAD in coming days.
NZD – still the loser against the Aussie, our key benchmark, with the next notable zone in AUDNZD up into 1.0800-50.
SEK – EURSEK at risk of a squeeze up into the next layer of resistance into 10.25-30 if this bout of weak risk sentiment persists – but still like eventually fading rallies.
NOK – after the steep crude oil rally, further retracement in oil prices could bring 10.50 into view again in EURNOK, with anything above that possibly representing a longer-term setback than one would have hoped for realizing a resumption of the down-trend and the 10.00 level anytime soon.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
